Greenspan remarks raise same old questions about GSEs

Federal Reserve Chairman Alan Greenspan's remarks last Monday - to the effect that government support for Fannie Mae and Freddie Mac may be causing investors to underestimate the risk of dealing with both GSEs' securities - did not cause much of a stir in the agency and mortgage-backed markets.

However, it brought to light once again the ever-present debate about the power that these two mortgage giants hold: is it too much or just right to carry out their government-given mission?

The two agencies, particularly Fannie, have been getting a lot of flak lately. Greenspan's statements came just a week after Fannie announced and then rescinded a clean-up call of MBS worth roughly $1.5 billion of unpaid principal (see ASR, 04/22/02), a move that caused a significant disturbance in the Fannie premium market.

The Fed Chairman's comments also gave ammunition to the Wall Street Journal's ongoing campaign against Fan and Fred (see ASR 02/25/02, p.1). "Mr. Greenspan has criticized this implicit government support as a subsidy to housing that distorts the economy's allocation of resources," said an article that appeared in the Journal last Tuesday. "But in a speech last night, he went further, suggesting that subsidy might also be causing the risk in their derivatives transactions to be understated, though he didn't say that had actually happened."

But some market observers maintain that Fannie and Freddie are more likely to be careful about the risks that they take because their survival largely depends on the stability of their earnings results.

According to Steven Point, a fixed-income portfolio manager at Glenmede Trust Co., Fannie and Freddie have always done a lot in terms of disclosure and their aim has always been to try and get a higher multiple in terms of their stock price. "It has become a challenge for these two to prove to the investor community that they could be well run and be profitable under different interest rate and economic scenarios," he stated.

The GSEs' focus, therefore, is not really on trying to jeopardize their earnings by doing risky things on their respective balance sheets. Rather, Point said, Fannie and Freddie's managers pay close attention to achieving a higher stock multiple based on presenting a consistent and very stable earnings picture.

Another MBS source said that the problem that these two GSEs face is that they are serving two masters: taxpayers and shareholders. On the one hand, taxpayers are rightly concerned that the agencies are getting too big and risky while on the other hand, they also have shareholders who are looking for profit.

"Fannie and Freddie are regulated financial institutions, or they are quasi-government agencies who also have shareholders looking for growth," stated an MBS analyst. "How do you get real growth through a regulated business?"

He added that another issue is that because of the Enron debacle, it has become a market where opaque financials are just not being tolerated anymore. "You can bully the editorial staff of the Wall Street Journal, but you cannot bully the Chairman of the Fed," the analyst noted. "It's a new world out there and people are not going to only look at earnings growth and hold their nose and say, We don't care how they are going do it, as long as we get it.' "

The case of the

Mom and Pop thrifts

Glenmede's Point said that it would seem more prudent to have the risk in mortgage portfolios handled by large institutions like Fannie and Freddie - though not necessarily just the two of them - who could attract talented individuals and invest in the kind of asset/liability systems needed to handle the interest rate and credit risks involved in these operations.

He cited the period when the asset/liability management aspect was spread across thousands of institutions or Mom and Pop thrifts that did not have the staffing or the technology to deal with these risks, a situation which led to a huge bailout. Aside from this, having just a few entities to monitor is much more efficient than overseeing thousands of institutions that have the likelihood of getting into a distressed situation.

Meanwhile, analysts said there is little chance that Congress will be changing the regulations on how GSEs are currently operated, at least for this year. It is already May, they said, and Congress is still working on other important legislation such as the appropriations bill and the bankruptcy reform act, which has been pending for a while now.

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